Editor’s Pick | The latest chapter in the ongoing network charging saga

This article was originally published in Energy Spectrum Issue 692 on 18 November 2019.

With the publication of a decision on the Targeted Charging Review (TCR) Significant Code Review (SCR), Ofgem’s attempt to reshape electricity network charges to be fit for a world of decentralisation and electrification have entered their next phase.

While some stakeholders will value the end to uncertainty this decision provides, there will no doubt still be plenty of concern given the number of variables still up for grabs, especially among small generators and, when they find out, load managing customers.

A long time ago…

The TCR is just one element of a package of major reforms which are underway. It is, in theory, complemented by the Network Access and Forward-Looking Charges SCR (the “Access SCR”).

Both are looking at Distribution and Transmission Use of System (DUoS and TNUoS) charges and both have wide-ranging implications.

Judge me by my size, do you?

Don’t be fooled by the dictionary definition of residual – “remaining after most of something has gone” – at £4bn/year residual network charges represent around half of the total annual network cost.

In Ofgem’s words, they should be “designed to recover the rest of the relevant network company’s allowed revenues once forward-looking charges have been levied”.

Crucially, forward-looking charges should give users signals about how their behaviour can impact future network costs (hence “forward-looking”) while residual charges should not. The focus of the Access SCR is on giving users cost-reflective signals, while the TCR tries to ensure network companies can recover their allowances without distorting those signals.

Hello, what do we have here?

The TNUoS demand residual is currently around £50/kW at TRIAD and makes up the bulk of the TRIAD signal. This goes beyond distorting the underlying signal and is really the main driver behind the huge incentive to pursue TRIAD avoidance.

Similarly, the DUoS demand residual averaging at ~£8/MWh (varying by distribution network operator (DNO) area) for usage at any time creates a significant incentive to reduce net usage.

All of this is embodied in a charge element which is not supposed to give a cost signal.

A lot of special modifications

Ofgem has been keen throughout the TCR to move residual charges to a fixed basis. Fixed charges are unavoidable for anyone wanting to stay connected to the network, and so, it believes, are appropriate for the recovery of the fixed costs of operating networks.

The problem comes with determining how much each customer should pay, and how different the fixed charges should be between each group. No one would argue that a domestic customer’s contribution to residual charges should be the same as for a steel plant. In-between these extremes there are more nuances to be explored.

Aggressive negotiations

A key problem has been how to differentiate between customers that would easily be classed into groups with big internal variation. There is a huge variation in the size of (high voltage) HV distribution connected customers, from supermarkets with relatively modest usage through to small factories with high usage.

Ofgem has sought to avoid any ‘linear’ element to the charge, by which a user can reduce their agreed capacity with the DNO, benefitting from a lower charge. These big groups of users will be segmented based on bands: The four segments for non-domestic distribution connected users will be split into bands based on the 40th, 70th and 85th percentiles of net volume (small LV) or agreed capacity (large LV, HV and EHV).

While this might avoid an immediate reduction in charges for customers having a lower agreed capacity, those close to the boundaries will face a significant incentive to squeeze themselves down into the lower segment.

Ofgem has heard the arguments against banding in this way but remains convinced that it is better than the alternatives. But we believe there is a significant chance of gaming the thresholds for business consumers especially if third party intermediaries work out that they can gain by taking a share of any savings they may make from doing this.

TNUoS residual charges will change from April 2021 and DUoS from April 2022.

Here we go again…

If you thought you’d heard the back of the phrase “embedded benefits” (after years of debate and a Judicial Review), think again.

Embedded benefits arise when distribution connected generators can access revenues (or cost reductions) which transmission connected generators cannot. They typically occur when suppliers are charged on a ‘net’ demand basis. This means distribution connected generators can reduce suppliers’ net demand in a region, so reduce suppliers’ exposure to the charge in question, and be paid for doing so.

The biggest of them is in the process of being removed under the phased implementation of Connection and Use of System Code (CUSC) changes CMPs 264 and 265.They see suppliers charged the TNUoS demand residual (that hefty ~£50/kW at TRIAD again) on a ‘gross’ demand basis and, from April 2020, no benefit paid to generators.

* small – whole current metered and without an agreed capacity with the DNO

** large – current transformer metered and with an agreed capacity with the DNO

There is another

An embedded benefit remains for Balancing Services Use of System (BSUoS) charges, where suppliers are charged on a ‘net’ demand basis, so distribution connected generators receive payments, while transmission connected generators are required to pay BSUoS charges.

The opposite also arises in current arrangements for the Transmission Generator Residual (TGR), which is used to ensure GB TNUoS charges are compliant with EU regulations requiring average transmission connected generator TNUoS to be in a €0-2.50/MWh range. This gives a cost reduction to transmission connected generators which distribution connected generators cannot access.

Tell me you have a backup plan

Ofgem has gone partway to removing the discrepancy between distribution and transmission connected generators’ BSUoS exposure but stopped short of going the whole hog. The TCR decision will result in suppliers being charged BSUoS based on gross demand, so distribution connected generators will no longer be paid to reduce suppliers’ exposure.

But transmission connected generators will still cry foul at being exposed to the cost of BSUoS charges while their distribution connected competitors are not.

Ofgem has announced the launch of a second BSUoS “Task Force” to address this issue. The first Task Force fed its findings into this review – in short, that BSUoS should not seek to give signals to users and should be treated as a cost recovery charge. Without pre-judging the work of the second Task Force, it seems likely that it will seek to put into action the sentiment of its predecessor and suggest reforms to BSUoS to treat it akin to demand residual charges – and so recover from demand customers only.

Fair and square

Ofgem wants to set the TGR to zero. But, as noted it is currently used to keep GB TNUoS compliant with EU regulation. If it were removed in isolation, we would immediately be non-compliant.

Options to maintain compliance are to redefine the way in which average generator TNUoS is calculated for the purposes of the cap by discounting some elements (being considered under CMP 317), or to introduce an ‘adjustment charge’ – which at face value sounds a lot like a renamed TGR.

What is it they’ve sent us?

But, that’s not quite the whole story. This decision marks a key milestone in the progress of the SCR – the point at which Ofgem has reached its conclusion and handed over responsibility for putting it into action to the network companies.

But it is far from over. DNOs and the ESO will need to progress changes through open governance – often easier said than done. And while implementation in April 2022 may seem a long way off, for distribution companies this puts a relatively tight timescale on the code modification process, with an Ofgem decision needed in 10 months’ time (by 30 September 2020) to allow for the 18-month window between changes being approved and their implementation in charges.

While a little more time is available to develop TNUoS modifications (decision needed in November 2020), the shorter implementation window ahead of April 2021 may prove challenging. This decision represents a significant shift in the structure of TNUoS charges, so will have knock-on impacts on IT systems across multiple organisations.

Instead of a big dark blur, I see a big light blur

The open governance processes create opportunities for parties to have their say on aspects of the decision. This will be especially true given there are significant gaps in the detail, such as when customers can change bands, defining ‘final demand’ and compliance with the €0-2.50/MWh cap for generator TNUoS.

These opportunities to question the detail of the decision leave the door open to parties wishing to disrupt implementation. And there are likely to be plenty of them.

The impact of these changes on distribution connected generators, both front of and behind the meter is significant. The removal of the BSUoS embedded benefit at ~£2.50/MWh on average will impact many business cases. Similarly, behind the meter, dispatchable generation has had a reliable revenue stream based on TRIAD avoidance and DUoS residuals for many years. Already, arguments are being made that the change will actively hinder decarbonisation by stymying small-scale generation. So, expect fireworks as these code modifications progress.

Didn’t we just leave this party?

Many will be eyeing the Access SCR with some trepidation. It has a wide-reaching scope and equally wide-reaching impacts – which could go well beyond those of the TCR. There will also be some dismay at the decision to implement some TCR changes in April 2021, some in April 2022, and Access SCR changes in April 2023, without considering them in the round.

This decision is a key step towards implementation of the TCR. Loud voices have told Ofgem that the damage it will do to behind the meter and other small embedded generation runs counter to the government’s decarbonisation objectives, but the blunt fact is that Ofgem continues to see this as a step towards net zero, despite the short-term pain. Questions will continue to be raised, and the code modification process will no doubt be a bumpy ride against tough timescales. Responsibility now passes to the network companies, who will be keen to deliver even if they do not have responsibility for implementing the new framework.

If you have enjoyed reading Andrew’s views and want to read about the latest developments in the energy market, please contact us for a month’s trial of Energy Spectrum.

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